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Daron Acemoglu on Inequality

If you’re even a little bit interested in income inequality and how it matters, this Browser interview with MIT economist Daron Acemoglu is a must-read. Acemoglu explains how economists generally think about inequality:

The default position of economists is that inequality reflects the unequal human capital or productive capabilities of different workers. If you start with that premise – that what people earn is commensurate with their contribution to their employer, and also perhaps to society – then greater inequality tells you something about how people’s productivities have evolved over time. This is by no means what every economist believes, but it’s a common view. Economists have cut their teeth on inequality by looking at things like the increase in the college premium over the last 30 years in the U.S. and other economies, as well as the increase in the gap between relatively high earners – the 90th percentile of income distribution – versus the bottom 10th percentile. We’ve seen a big increase in inequality, measured in various ways, and this reflects the fact that the top people, the more educated, high earners have become more skilled. Technology has favored them, globalization has favored them, and inequality has increased for that reason.

And here’s Acemoglu on the average layman’s view of inequality:

My caricature of a layman’s view is that inequality is an indication of something that is failing in society. If a group of people used to earn twice as much as another group of people, and then, over 20 years, that ratio increases to four, that’s something that is concerning and might indicate a failure of social policy.

Acemoglu also discusses CEO compensation, inequality in other countries, the education system and the recent financial system.

frankenduf

December 16, 2011 @ 6:08pm

not sure if the straw economists have heard of politics, but legislative distribution of wealth upwards is the predominant explanation for stratification- putative recent examples include the transfer of $ trillion from 'layman' taxpayers to the financial industries and the ECB's ratcheting up of austerity policies which have increased the suffering of periphery european 'laymen' in order to preserve interest levels favorable to the wealthy in the core- it would be hard for me to believe that anyone alive and breathing over the past 5 years doesn't understand this

James

December 16, 2011 @ 7:00pm

It would be interesting, though, to discover what portion of increased wealth disparity is due to money going to the financial sector, and what part is due to the increased wealth in the tech sector. Looking at the Forbes 400 list, I see a lot of tech names in the top 20 or so.

I'll also note that virtually all of the tech sector wealth represents upward mobility, in many cases to an extreme degree.

Sam_L

December 16, 2011 @ 6:11pm

I think that upward mobility (or lack thereof) would be a better indicator of failed social policy. If we are still seeing a similar percentage of people moving up into the highest levels, then we would be justified in thinking that the contribution theory is an adequate explanation. On the other hand, if fewer and fewer are able to move upward, then we may be looking at systemic barriers that are the result of social policy.

Joe J

December 16, 2011 @ 7:01pm

Good point, and even a cursory look at Forbes top 10, would have to admit that they were not born in riches. Even the Wldons, who inherited from their Father, it was wealth gathered within one generation, after they were born. The systemic barriors that some claim, are no where as rigid as some claim. Upward and downward mobility are still alive and well in the USA. Uppward has taken a minor hit, but we are in the middles of a depression.

It is far from the claim that the deck is so unfailrly stacked against them that it is impossible for anyone not connected to advance.

John J.

December 16, 2011 @ 10:46pm

Great insight. It pains me when I hear that inequality has risen because Wall Street is greedy. I like this and economist Ed Glaeser finding that the spread of income of those who have college degrees and those who don't have had over double the impact of the gains "stolen" by the 1% these past 30 years (and even more for Masters and higher).

In times where education outpaces technology, inequality and the Gini coefficient decreases. This is consistent with the surge in college enrollment and high returns to human capital between WWII and the mid-70's. However, when technology outpaces education, the reverse is true. We've seen this since the late 70's through diminishing HS proficiency, declining college completion, and fewer productive college majors.

Jonathan

December 17, 2011 @ 1:00am

I encourage you to click through to read what Acemoglu has to say about the top 1%. Something about "the economists' story become harder to swallow...."

Chris

December 17, 2011 @ 6:21am

Strikes me that the human race is consistent and people will generally act in the same way. So if the opportunity to increase ones wealth arises (at the expense of others ie shareholders) then all of us will likely act in a similar manner albeit at different degrees depending on our audacity. So you cannot blame the individuals if you are angry at the ceo compensation fraud that has occurred in the last 10 years...we need to be angry at the regulatory system and the boards of directors that have failed to protect shareholder interests. From an economics perspective....to assume that a CEO that has clearly failed is still worth 25mm a year is a bit false right (ie read "Why Not Occupy Newsrooms?" By DAVID CARR).

Life is all about systems in which we all act to maximize our utility. So don't hate the players, hate the guys the make and enforce the rules.

Stephen M (Ethesis)

December 17, 2011 @ 3:49pm

Though the average layman's view is probably better put that the specific failing that has happened in inequality is that someone has gamed the system or is exerting a kelptocracy tax of some sort.

I see inchoate versions of that all the time.

Though I really expected to see an essay on the reasons for the difference in pay between men and women here.

Shane

December 17, 2011 @ 6:14pm

Why is American income inequality so much higher than many other developed countries? If inequality is just the natural consequence of technological change, I would imagine it would be common to all of the wealthier countries. Instead we see a fair bit of variation.

That said, I also note this OCED paper showing that between the mid-1980s and late 2000s, income inequality rose in nearly every OECD country. Perhaps there is both a general trend because of technology and educational changes, and alleviating policies that changes the resulting level of inequality?
http://www.oecd.org/dataoecd/32/20/47723414.pdf

aepxc

December 18, 2011 @ 1:25am

We should distinguish between wealth inequality and income inequality. In a heavily capital-centric economic arrangement, income inequality is a consequence of wealth inequality, as one's compensation depends on the value one produces, and the value one produces is mostly determined by the amount of capital one controls. It is quite obvious that, for instance, a barely competent individual in charge of $100 million worth of capital will be responsible for the production of more wealth than a genius pauper. In fact, the genius pauper would probably have a hard time even finding anyone to give him or her the time of day to demonstrate his or her genius. Moreover, such an economic arrangement is self-reinforcing. The more capital one has, the more value one can create, so the more income one can earn, so the more capital one has. The resultant trend towards ever greater economic bifurcation (small number of highly compensated elite positions generating most of the value but through rentier-like dominance over available capital vs. dead-weight pointlessness for everyone else, regardless of human capital), both on the individual and on the corporate level (how many medium-sized companies are still having a comfortable existence?) is exactly what would be expected.

Read more...

James

December 18, 2011 @ 3:14am

In real life, your genius pauper works his way through college, gets a degree in something like computer science, moves to Silicon Valley, and makes anything from a decent living to a few billion.

Meanwhile your barely competent individual will make a series of bad decisions, and that $100 million will melt away.

aepxc

December 18, 2011 @ 9:13pm

You mean in an Ayn Rand novel, not "real life", right?

In real life that would depend much more on the ability to hustle, rather than the getting of a degree (Gates, Jobs, Zuckerberg dropped out from undergrad, Page and Brin dropped out from grad school, etc), and on luck. On the other hand, one would need to be strikingly, strikingly incompetent to piss away a head start – look at GWB's career path.

In any case, even your hypothetical reinforces my original point – the genius starts from low compensation and hopefully manages to work up, while the competent starts from high compensation and might gradually decline – income inequality is mostly the product of capital access, not human talent.

human mathematics

January 6, 2012 @ 7:09am

Think about it from a (neo)industrial perspective--the institutions that form our society. Without limited liability, banks, courts, lawyers, and other appendages of modern finance, it would be impossible for anyone to retain $10^9 in earned wealth. Our institutions protect the supremely wealthy much more than they protect those who can't afford lawyers.

Likewise, here's a simple thought experiment. Who benefits more from police/military protection: someone with $10,000 of assets, or someone with $10,000,000 of assets? The same is true of courts etc.